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Rosy Spring for Tobacco Giants?

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The tobacco industry hopes to turn around in the coming spring after poor crop last year owing to a drought-plagued season. The tobacco giants like Philip Morris International Inc. (PM - Analyst Report) and Reynolds AmericanInc. (RAI - Analyst Report) anticipate a higher price for their cigars on the back of a better yield by Burley farming, the key industry in Kentucky, powered by a favorable curing condition.

White Burley is a strain of tobacco that is known for its capacity to absorb sugar and flavoring. Burley was first grown in Ohio. However, at present it is predominantly a product of Kentucky and Tennessee. It revolutionized the smoking and chewing industry after the Civil War and had an equally strong impact on the cigarette industry during World War I.

The late planting season owing to steady rain last spring was followed by a dry summer that was a proper curing season for the burley plants. The post-harvest curing process changes long green burley tobacco leaves to a dark reddish brown tint desired by buyers.

Burley contract volume was significantly reduced in 2010 because of the softness in both domestic and international markets. Moreover, a prolonged drought last year combined with hot temperatures caused much of the burley crop to dry too fast in barns. That left much of the leaf with an undesired light tan color. Thus, market prices fell and the contracts with farmers were rejected by the tobacco biggies.

However, experts commented that the crops which are being readied for availability in the market coming spring are 64% good, 22% fair, 10% excellent and 4% poor or very poor. They are also of the opinion that these crops could be ranked the highest in quality in the past three or four years. These high quality crops ought to fetch a high reward for the industry.

Clouds loomed over the industry for a long time as governments in several countries imposed bans on marketing and packaging to bring down smoking levels in their respective countries.

The Food and Drug Administration (FDA) in a recent ruling has asked the tobacco giants of the United States to print the latest design including the graphic representations of a dead body, cancerous lungs and rotten teeth on their cigarette packets from 2012.

The Australian government has taken a stricter stance on tobacco giants, imposing higher taxes plus an order to expand the size of the existing graphic warning labels.

Five tobacco giants across the globe namely Reynolds American Inc., Lorillard Inc. , Ligget Group, Santa Fe Natural Tobacco, and Commonwealth Brands have filed a case against the FDA for imposing labels that are more likely to cut the number of smokers rather than helping consumers make a free choice. Philip Morris launched a multibillion-dollar legal action against the Aussie government’s ruling of plain packaging of cigarettes.

However, the tobacco industry also has many positive points to look forward to that will boost its growth in the near future. Though government regulations increasingly discourage smoking, the industry is heading toward a growth phase, with exports on the rise. Major export markets like China, which has less stringent anti-smoking regulations, will drive demand in the near future.

Moreover, fast growing population coupled with rising disposable income in the developing countries are expected to fuel the higher tobacco consumption in these regions. Plus, governments are unlikely to limit price increases in tobacco products.

However, Reynolds American and Lorillard hold Zacks #3 Rank, which translates into a short-term Hold rating. Philip Morris holds a Zacks #2 Rank, which equates to a short-term Buy rating.

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